U.S. Bancorp — First-Quarter 2013 Form 10-Q
Business context and period. U.S. Bancorp is a diversified financial services company. This unaudited quarterly filing covers the three months ended March 31, 2013; year-over-year comparisons are to the three months ended March 31, 2012, unless otherwise noted. Balance-sheet comparisons are generally to December 31, 2012. Dollar amounts below are in billions unless stated otherwise.
Key financial results
| Metric | Q1 2013 | Comparable period / change |
|---|---|---|
| Net income attributable to U.S. Bancorp | $1.428 | $1.338; up 6.7% |
| Diluted EPS | $0.73 | $0.67; up 9.0% |
| Total net revenue, taxable-equivalent basis | $4.874 | $4.929; down 1.1% |
| Net interest income, taxable-equivalent basis | $2.709 | $2.690; up 0.7% |
| Net interest margin, taxable-equivalent basis | 3.48% | 3.60% |
| Noninterest income | $2.165 GAAP | $2.239; down 3.3% |
| Noninterest expense | $2.470 | $2.560; down 3.5% |
| Provision for credit losses | $0.403 | $0.481; down 16.2% |
| Net charge-offs | $0.433 | $0.571; down 24.2% |
| Net charge-offs / average loans, annualized | 0.79% | 1.09% |
| Return on average assets / common equity | 1.65% / 16.0% | 1.60% / 16.2% |
| Efficiency ratio | 50.7% | 51.9% |
The filing reports GAAP net interest income of $2.653 billion and taxable-equivalent net interest income of $2.709 billion. GAAP income before taxes was $1.945 billion. The taxable-equivalent presentation adjusts for tax-exempt income; the filing’s selected-data table uses that basis for certain revenue and pretax measures.
- Balance sheet and funding: Total assets were $355.4 billion, loans $223.4 billion, investment securities $75.3 billion and deposits $248.0 billion at March 31. Period-end long-term debt was $25.2 billion and short-term borrowings $27.1 billion.
- Liquidity: Cash and due from banks totaled $6.9 billion. The company reported $56.3 billion of unencumbered available-for-sale and held-to-maturity securities and an additional $66.6 billion of potential borrowing capacity at the FHLB and Federal Reserve against available collateral.
- Credit quality: Nonperforming assets were $2.406 billion, down from $2.671 billion at year-end; the allowance for credit losses was $4.708 billion, or 2.11% of period-end loans. Nonperforming assets excluding covered assets were $2.029 billion.
- Capital: Tier 1 capital, total risk-based capital and leverage ratios were 11.0%, 13.2% and 9.3%, respectively. Management reported all regulatory ratios above “well-capitalized” requirements. U.S. Bancorp shareholders’ equity was $39.5 billion.
- Cash flow: Net cash from operating activities was $1.668 billion, versus $3.091 billion in Q1 2012; investing activities used $1.524 billion, versus $5.782 billion; financing activities used $1.464 billion, versus $1.710 billion. Cash and due from banks declined $1.320 billion during the quarter.
Material changes and management commentary
- Earnings rose despite lower revenue, supported by lower expenses and credit costs. Revenue declined primarily because mortgage banking and other income fell; higher card and merchant processing revenue and trust and investment management fees partly offset the decline.
- Net interest income increased modestly as average earning assets grew 4.6% and funding costs fell, but margin compressed 12 basis points year over year, reflecting lower asset yields and a larger mix of lower-yielding assets.
- Average loans grew 5.8% year over year, led by residential mortgages and commercial lending. Period-end loans were nearly unchanged from December 31, 2012. Average deposits grew 7.3% year over year, while period-end deposits declined 0.5% from year-end.
- Credit trends improved overall: lower commercial and commercial real estate losses contributed to the decline in charge-offs, and nonperforming assets fell. Management expected nonperforming assets to trend lower in Q2 2013 and net charge-offs to be relatively stable in Q2, subject to economic conditions.
- Expense reductions reflected lower litigation, regulatory, insurance and FDIC-related costs, as well as lower marketing expense. Compensation and employee-benefit costs increased, including higher pension costs and staffing for business initiatives.
- Management did not provide specific earnings or revenue guidance in the supplied filing text. It said the proposed Basel III rules were not expected to materially affect the financial statements.
Risks, contingencies and unusual items
- Legal and mortgage-related contingencies: The Visa litigation liability, net of related escrow funding, was $65 million; the settlement remained subject to court approval and challenges. The company also had a $130 million accrued liability for mortgage-related actions and related matters. Its reserve for mortgage representation-and-warranty obligations was $233 million, versus $240 million at year-end.
- Investment impairment and valuation: The company recorded $7 million of impairment charges in earnings on non-agency mortgage-backed securities, primarily from lower expected cash flows. It warned that adverse market conditions could lead to further impairment. Available-for-sale securities had $156 million of gross unrealized losses; management said it did not plan to sell securities with unrealized losses and did not expect to be forced to sell before recovery of amortized cost.
- Interest-rate and market sensitivity: A gradual 200-basis-point rate change was subject to a 4% decline limit for projected 12-month net interest income, and the company reported being within policy. A 200-basis-point increase was estimated to reduce market value of equity by 1.7%; a decrease, where possible at current rates, by 6.3%.
- European exposure: The company reported no European sovereign debt, but had $70 million amortized cost of perpetual preferred stock issued by European banks, with $7 million of unrealized losses, and approximately $455 million deposited with European banks.
- Subsequent event: In April and May 2013, the company transferred control of certain consolidated community-development and tax-advantaged investment entities and deconsolidated them. This removed approximately $4 billion from both other assets and long-term debt; management said the transaction would not materially affect future income statements or cash flows.
- The filing identifies economic conditions, real-estate markets, credit quality, interest rates, regulation, competition, operational and liquidity risks, and the reliability of critical accounting estimates as factors that could cause actual results to differ from forward-looking statements.
Most important facts for investors to verify
- Whether revenue and margin trends stabilize, particularly as loan and securities yields remain under pressure and mortgage banking revenue declines.
- Whether management’s Q2 expectations for stable charge-offs and declining nonperforming assets are borne out, and how allowance coverage changes as credit conditions evolve.
- The sustainability of expense reductions, given rising compensation, employee benefits and pension costs, and the period-to-period variability of litigation and regulatory expenses.
- The status and ultimate costs of Visa litigation, mortgage-related investigations and representation-and-warranty claims, including whether existing accruals remain adequate.
- The sensitivity of earnings and capital to interest rates, securities valuations, mortgage servicing rights assumptions and any additional impairment in non-agency securities.
- The effects of the post-quarter VIE deconsolidation and the company’s liquidity, funding mix and capital position under changing market or regulatory conditions.